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Welcome to the October episode of Bay Street Views. My mission is to educate, inform, and help you make better financial decisions. Today I'd like to discuss what's fueling the recent bout of market turbulence and the biggest risk to portfolios, stagflation. In my 18 years of managing investment portfolios, I don't recall a single period when investors didn't have to worry about a long list of issues, any one of which could have derailed their equity markets.

Each economic cycle comes with a unique set of circumstances, risks, and opportunities. And the current cycle is no different. Over the past few weeks, the markets have experienced daily swings from extreme optimism to pessimism. The updates and equities have been on the back of strong corporate profits, excessively accommodating the monetary and fiscal policies and plateauing COVID-19 figures.

Another important positive for stocks remains the ultra low interest rate environment, making equities more appealing than bonds for a $5 trillion pile of cash sitting in brokerage accounts. The down days in the market have been fueled by worries about persistent inflation, waning momentum in the economy, rising bond yields, a broken supply chain, and uncertainty in China's real estate market. From this extensive list of concerns that keep investors up at night, stagflation is the most pervasive threat to the financial markets.

Stagflation is a toxic combination of a stagnating economy and rampant inflation. It's a situation we haven't had to deal with since the 1970s when we had double digit inflation, two recessions, high energy prices, and widespread unemployment. It was a real mess. Recently, the term stagflation has been used frequently in the financial media, scaring the living daylights out of many investors, because stagflation is so tricky to fix.

The central banks can increase interest rates to reduce inflation or cut interest rates to stimulate the economy, but they can't tackle both inflation and slowing economy at the same time. I feel it's important to discuss the likelihood of stagflation and the steps that can be taken to protect portfolios against this low probability but high impact scenario. In my opinion, having a 1970s style stagflation is an unlikely scenario for several reasons.

First, inflation expectations, which often become a self-fulfilling prophecy and explain roughly half of actual inflation are still below the 2008 level and far below the level seen in the early 1970s. Second, a major source of recent inflation is a temporary disruption to the global supply chain, which should get resolved once the COVID numbers recede and manufacturing hubs in Asia and ports in the US and Europe start to operate at full capacity.

Third, gains in labor productivity led by technological innovations should keep wage growth an important catalyst for inflation in check. Also, the aging population is deflationary. Typically, people spend the most when raising families. As they get older and become empty nesters, they often downsize and spend less. Less spending hinders economic growth, which in turn brings inflation down. It is important to recognize that while we are far from a full-blown stagflation, there are mild hints of it in today's economy.

It's equally important to hedge a portfolio against this threat just in case the mild signs of stagflation morph into a more serious problem. Historically, central banks raise interest rates during high inflation to slow the economy and bring prices down. Rising interest rates would spell trouble for stocks as the cost of borrowing would go up, and corporate profits will get squeezed. This chart shows the quarterly performance of equities during various economic scenarios. And it shows that stocks struggled the most during stagflation.

Higher rates will also be troublesome for bonds, since increasing rates would send bond prices lower. During stagflation, benefits of diversification in the classic 60/40 stocks and bonds portfolio are diminished because bonds would add to risk rather than hedging against it. So how do you protect the portfolio in the unlikely event of full-blown stagflation? Historically, sectors that have worked relatively well in this treacherous environment are Healthcare and Energy.

In addition, banks and real estate stocks may do well, but to a lesser degree. Irrespective of economic conditions, consumers prioritize spending on health care over other expenditures. Demand for health care is relatively immune from inflationary pressures, except for elective procedures, patients are not likely to skip medical care because of increasing prices. Thus, the health care sector holds up relatively well when the economy slows down and inflation picks up.

The energy sector is another strong performer during stagflation as commodities and inflation move in tandem. During stagflation in the 1970s, bank stocks performed well, compared with the overall market. To fight inflation, the central banks raise interest rates. When rates go up, banks become more profitable as the spread between what banks pay you on deposits and charge you on the loans widens. This holds until their rates are hiked too much to the point of choking the economy. The same goes for real estate.

In the initial phase of the inflationary period, real estate provides a good hedge until higher mortgage rates hinder demand for housing. In conclusion, the daily game of ping pong between the market bulls and bears is likely to keep equities volatile for the foreseeable future. The risk of stagflation is fairly low, but it cannot be completely ruled out. If inflation and the economy move in opposite directions, the central banks will face a serious dilemma. They will have to either raise rates to fight inflation but slow the economy due to higher borrowing costs, or lower rates to boost the economy further fueling inflation.

Ideally, the central bank would raise rates just enough to rein in inflation without stifling the economy, but finding the right balance is easier said than done. Determining the trajectory of the economy is as difficult as guessing the future actions of central banks. Thus, it's best to have a portion of the portfolio invested in sectors, including healthcare, energy, and to a lesser degree, banks and real estate that should do well in this stagflationary environment.

Keep in mind that portfolio should hedge against multiple risks, including stagflation. Most importantly, remember that most of the returns in stocks happen in big bursts right after a period of fear. Stay invested, be patient, and keep a balanced approach in the portfolio. Thank you for watching.

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Welcome to the October episode of Bay Street Views. My mission is to educate, inform, and help you make better financial decisions. Today I'd like to discuss what's fueling the recent bout of market turbulence and the biggest risk to portfolios, stagflation. In my 18 years of managing investment portfolios, I don't recall a single period when investors didn't have to worry about a long list of issues, any one of which could have derailed their equity markets.

Each economic cycle comes with a unique set of circumstances, risks, and opportunities. And the current cycle is no different. Over the past few weeks, the markets have experienced daily swings from extreme optimism to pessimism. The updates and equities have been on the back of strong corporate profits, excessively accommodating the monetary and fiscal policies and plateauing COVID-19 figures.

Another important positive for stocks remains the ultra low interest rate environment, making equities more appealing than bonds for a $5 trillion pile of cash sitting in brokerage accounts. The down days in the market have been fueled by worries about persistent inflation, waning momentum in the economy, rising bond yields, a broken supply chain, and uncertainty in China's real estate market. From this extensive list of concerns that keep investors up at night, stagflation is the most pervasive threat to the financial markets.

Stagflation is a toxic combination of a stagnating economy and rampant inflation. It's a situation we haven't had to deal with since the 1970s when we had double digit inflation, two recessions, high energy prices, and widespread unemployment. It was a real mess. Recently, the term stagflation has been used frequently in the financial media, scaring the living daylights out of many investors, because stagflation is so tricky to fix.

The central banks can increase interest rates to reduce inflation or cut interest rates to stimulate the economy, but they can't tackle both inflation and slowing economy at the same time. I feel it's important to discuss the likelihood of stagflation and the steps that can be taken to protect portfolios against this low probability but high impact scenario. In my opinion, having a 1970s style stagflation is an unlikely scenario for several reasons.

First, inflation expectations, which often become a self-fulfilling prophecy and explain roughly half of actual inflation are still below the 2008 level and far below the level seen in the early 1970s. Second, a major source of recent inflation is a temporary disruption to the global supply chain, which should get resolved once the COVID numbers recede and manufacturing hubs in Asia and ports in the US and Europe start to operate at full capacity.

Third, gains in labor productivity led by technological innovations should keep wage growth an important catalyst for inflation in check. Also, the aging population is deflationary. Typically, people spend the most when raising families. As they get older and become empty nesters, they often downsize and spend less. Less spending hinders economic growth, which in turn brings inflation down. It is important to recognize that while we are far from a full-blown stagflation, there are mild hints of it in today's economy.

It's equally important to hedge a portfolio against this threat just in case the mild signs of stagflation morph into a more serious problem. Historically, central banks raise interest rates during high inflation to slow the economy and bring prices down. Rising interest rates would spell trouble for stocks as the cost of borrowing would go up, and corporate profits will get squeezed. This chart shows the quarterly performance of equities during various economic scenarios. And it shows that stocks struggled the most during stagflation.

Higher rates will also be troublesome for bonds, since increasing rates would send bond prices lower. During stagflation, benefits of diversification in the classic 60/40 stocks and bonds portfolio are diminished because bonds would add to risk rather than hedging against it. So how do you protect the portfolio in the unlikely event of full-blown stagflation? Historically, sectors that have worked relatively well in this treacherous environment are Healthcare and Energy.

In addition, banks and real estate stocks may do well, but to a lesser degree. Irrespective of economic conditions, consumers prioritize spending on health care over other expenditures. Demand for health care is relatively immune from inflationary pressures, except for elective procedures, patients are not likely to skip medical care because of increasing prices. Thus, the health care sector holds up relatively well when the economy slows down and inflation picks up.

The energy sector is another strong performer during stagflation as commodities and inflation move in tandem. During stagflation in the 1970s, bank stocks performed well, compared with the overall market. To fight inflation, the central banks raise interest rates. When rates go up, banks become more profitable as the spread between what banks pay you on deposits and charge you on the loans widens. This holds until their rates are hiked too much to the point of choking the economy. The same goes for real estate.

In the initial phase of the inflationary period, real estate provides a good hedge until higher mortgage rates hinder demand for housing. In conclusion, the daily game of ping pong between the market bulls and bears is likely to keep equities volatile for the foreseeable future. The risk of stagflation is fairly low, but it cannot be completely ruled out. If inflation and the economy move in opposite directions, the central banks will face a serious dilemma. They will have to either raise rates to fight inflation but slow the economy due to higher borrowing costs, or lower rates to boost the economy further fueling inflation.

Ideally, the central bank would raise rates just enough to rein in inflation without stifling the economy, but finding the right balance is easier said than done. Determining the trajectory of the economy is as difficult as guessing the future actions of central banks. Thus, it's best to have a portion of the portfolio invested in sectors, including healthcare, energy, and to a lesser degree, banks and real estate that should do well in this stagflationary environment.

Keep in mind that portfolio should hedge against multiple risks, including stagflation. Most importantly, remember that most of the returns in stocks happen in big bursts right after a period of fear. Stay invested, be patient, and keep a balanced approach in the portfolio. Thank you for watching.

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Welcome to the August episode of Bay Street Views. My mission is to educate, inform, and help you keep emotions away from investment decisions. Today, I would like to discuss the opportunities and the risks climate change may pose to investment portfolios. Governments and private sectors are expanding their efforts to fight climate risk. Increased spending to slow down climate change is creating investment opportunities which well-diversified portfolios should capture.

Let's look at some of these opportunities. The burgeoning demand for electricity generated by renewables, solar, and wind has made companies operating in these segments highly sought after by investors. As shown on this chart, the clean energy exchange-traded fund, a basket of clean energy stocks has rallied in recent years. To date, I have not been comfortable investing in these businesses as most of them trade at inflated valuation multiples and have too much debt and volatility to my liking.

However, there are more cautious ways to expose a portfolio to the prevalent theme of climate change. I believe it would be prudent for a broader diversified portfolio to include investments in companies with products that could be in high demand due to extreme weather patterns. Some of the companies in this category would be Quanta Services, Generac Holdings and Danaher.

Quanta services specializes in repair and maintenance for the electric power, natural gas, telecommunications, and cable vision industries. Its services cover renewable energy solutions including solar, wind, and natural gas. The company should benefit from the multi-year ramp up in spending in a number of industries it services. As shown on this chart, increasing consumption of renewable energy in the US and the growing need to upgrade the aging energy network should give the company significant tailwind for the foreseeable future.

Generac Holdings is another business that continues to see demand for its products increase in some measure due to extreme weather events. The company designs and manufactures power generation equipment, serving residential, commercial and other industrial markets. Generac offers standby and portable generators for a variety of applications. For example, clean up operations after wildfires and hurricanes require the use of portable power-generating units.

The frequency and intensity of extreme weather events have been rising precipitously and so has the demand for Generac's power-generating units. Also, the company's revolutionary technology captures and stores electricity either from solar panels or the electrical grid. The company's residential power-generating units can store the unused energy generated by solar panels. The stored energy can be used during power outages, which makes households less dependent on the grid.

Another business of interest is Danaher. It focuses primarily on manufacturing scientific instruments and consumables in three segments, life sciences, diagnostics and environmental solutions. The company's water analytics and treatment business provide complete water cycle solutions. The growing world population and limited water supplies should be conducive for Danaher's water business.

Now, a few words on mitigating climate risk in the portfolio. While the trajectory, timing, and financial consequences of climate change are difficult to predict, investors need to adapt their strategies should the climate risk materialize. As such, to hedge against the broad spectrum of threats, including extreme weather events, it's critical to ensure a portfolio's asset mix includes some combination of bonds, gold, the US Dollar, Swiss Franc, and Japanese Yen.

Often, these asset categories and currencies hold up really well during times of uncertainty. In conclusion, the fight against climate change is gaining traction and presents unique investment opportunities. Numerous leading global companies have committed to obtaining 100% of their global energy needs from renewable sources. However, it will require infrastructure improvements to support this transition benefiting companies like Quanta Services and Generac Holdings.

Increasing spending on water quality and distributing this vital, but limited resource should benefit Danaher and other companies in this space with leading edge technologies. There are currently numerous ways to add water exposure to your portfolio, but it requires careful research to make sure it fits your overall investment objectives and risk tolerance.

Stay diversified, maintain a common-sense investing approach, and keep an eye on growing risks and opportunities. Thank you for watching, and stay safe.

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Welcome to the July episode of Bay Street Views. My mission is to educate, inform, and help you sidestep financial accidents. Today, I'd like to discuss prudent ways of investing when nearly all the major asset classes, including stocks, bonds, real estate and commodities, are expensive.

Most asset categories had a stellar performance over the past year despite the economic collapse due to the pandemic. Asset valuations have stretched and, in nearly all cases, well above the previous peaks.

As the saying goes, "a picture is worth a thousand words," so let the next few charts tell the story. This chart shows the ratio of the US equity benchmark, S&P 500, to the size of the economy. This metric tells us that the US equity market is nearly twice the size of the entire American economy, far exceeding the previous records.

And this chart here shows the historical valuation for bonds measured as the amount of savings it takes to generate a minimum wage income. In other words, you've got to have roughly $2 million invested in a 10-year Government of Canada bond to generate a minimum wage income. Needless to say, this level of income won't afford you a comfortable retirement lifestyle.

Let's look at the real estate market, which hasn't been this expensive since the housing bubble in 2007. Even the broad commodity index, which includes energy, livestock, industrial metals, grains, and other agricultural items, has been on a tear. And on a more adventurous note, cryptocurrencies, a new and growing asset class, have had a parabolic rise since the last year.

Many of you may wonder what the root cause is for this gravity-defying increase in asset prices. Here's my take on this critical question. The most important price in the financial markets is the price of money, which is the interest rates set by the central bank. Interest rates have been declining for years and reached rock bottom last year at the peak of the pandemic-induced crisis.

The law of supply and demand dictates that when interest rates go down, the demand for money and credit goes up, and vice-versa. Easy access to cheap credit encouraged spending and investments, which boosted prices for nearly all asset classes. When there is too much money chasing a finite number of investment opportunities, asset prices get inflated to fantastic levels.

So what is an investor supposed to do when nearly all asset classes appear to be richly valued and susceptible to correction from these historically hefty levels? I don't encourage the market timing because it is a fool's errand. Usually, the equity markets go up and down way more than you'd expect.

The good news is you don't have to get the market timing right to be a successful investor in the long run. There are ways you can invest when the markets are high, while intelligently managing the risk in several ways.

First, let's consider a strategy through the dollar-cost averaging. This approach entails investing a fixed dollar amount over a predetermined period. Let's suppose you've sold a rental condo for $520,000 and wish to deploy the funds into stocks.

But after seeing the charts I just shared with you, you are uneasy about investing the entire amount into equities as a lump sum. Instead, you may choose to invest $10,000 per week over the next 52 weeks. So it will take you a year to get your money invested.

The main advantage of the dollar-cost averaging is it reduces the risk of investing at the top of the market. If the market drops while you are cost averaging into stocks, your weekly contributions will buy you more shares at lower prices.

Let me give you a quick example. If $10,000 is buying you 100 shares of ABC stock at $100 a share and the stock drops 10% the following week, the same $10,000 will buy you 111 shares of the same stock. Eventually, when the equity markets recover, you could make a potentially bigger profit on a greater number of shares you've acquired.

The obvious disadvantage of the proposed method is missing out on higher returns should the equity markets rally in the near term. An important question to ask yourself is this-- what will disappoint you the most-- if you invest your money as a lump sum and the markets drop 10% or you dollar-cost average, the markets rally 10%, and you miss out on that upside?

When answering this important question, please keep in mind that losing money is twice as painful as the joy of making profits. A second approach to safeguard the portfolio is by owning assets that don't move in the same direction at the same time. In other words, own assets that have a low or negative correlation to one another.

This part tends to be often confusing to investors, who naturally wish to see all of their investments go up at the same time. However, if all portfolio holdings appreciates simultaneously, there is a pretty good chance they will all go down at the same time.

We want to avoid the extreme ups and downs in the portfolio. Let me give you one of many examples illustrating how the portfolio returns can be smoothed out.

Usually, when investors are feeling great about the economic outlook, they want to own risk assets, such as equities, so stock prices go up. Meanwhile, safe-haven assets, like the US dollar, Swiss franc, Japanese yen fall out of favor, and their values decline relative to the Canadian dollar. Owning stocks that are denominated in these safe-haven currencies could help you partially mitigate the downside risk.

For example, if during the next market correction, US equity benchmark drops 10%, and meanwhile, the US dollar goes up 4% relative to the loonie, your net loss on paper would be 6%, which is better than a 10% loss. Conversely, should the US market rally 10%, chances are the greenback will decline and it will reduce your overall profit.

A third solution to diversifying risk in the portfolio is to add alternative investments, such as long/short hedge funds to the portfolio mix. The hedge fund manager would seek to profit from buying undervalued stocks and selling short the overvalued equities.

Selling short means the fund manager borrows the overvalued stock to sell in the market when the price is high. If and when that stock price falls, the fund manager buys the stock at a lower price, returns the borrowed shares to the lender, and profits the difference between the sale price and the purchase price.

Let me give you an example of this strategy. Let's assume the fund manager believes Amazon is undervalued, so they buy that stock to profit if the price goes up. Meanwhile, the manager believes IBM is overvalued, so the stock is sold short to profit if the price declines.

Let's also assume that during with the next stock market correction, Amazon and IBM drop 15% and 20%, respectively. Thus, the fund loses 15% on Amazon but makes 20% on IBM, more than offsetting the losses on Amazon.

Obviously, the strategy does not always work out this well. There is a possibility that the long and short strategies could both fail. Thereby, instead of reducing risk as desired, it might be increasing volatility and potential losses. That's why a careful selection of an experienced investment team with a long track record in this particular strategy is so crucial.

In conclusion, investing when the various asset classes are as frothy as they are today is tricky. No single line of defense in the portfolio can offer ample protection if and when the market corrects from these lofty levels.

Instead, I believe in having multiple lines of defense through dollar-cost averaging, owning assets that have a low correlation with one another, and adding some exposure to carefully chosen long/short hedge funds.

Selecting investments for an all-weather portfolio is like deciding on the type of vessel when crossing the ocean. If you're on a speed boat when crossing the ocean, and the waters are calm at all times, it might be a fun but dangerous way of traveling. Should you encounter a storm on the high seas, as it often happens, the consequences might be dire.

On the other hand, should you be on an oil tanker, it might be a less stylish way to be crossing the pond, but it would certainly be a safer way to get to the final destination. Make your portfolio be an oil tanker constructed for all weather conditions on the high seas. Be diversified.

Thank you for watching today. Stay safe and be well.

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Welcome to the June episode of Bay Street Views. My mission is to educate, inform, and help you avoid financial accidents. Today I'd like to share with you effective tax strategies to help you keep more of the income you earn in your portfolio.

From my 20 years of experience, I find tax planning in most portfolios is often overlooked by investors, and that's because usually talking about tax planning is not all that much fun. I bet if I can help you find ways to keep more of your hard-earned money in your pocket, it will put a smile on your face and I may even get a compliment from you.

These days, it's hard to get enthused about the prevailing ultra-low interest rate on GICs and bonds. That's why I believe it's more critical than ever to enhance the tax efficiency of your income stream. I'm not here to replace your accountant, but I do want to make you aware of the tax planning tools you may still have available in the tool box.

First, let's briefly discuss a tax strategy through a spousal loan arrangement. Typically, this strategy is beneficial for couples where one spouse has significantly higher taxable income than the other. The objective is to shift future investment income from a higher-income spouse to a lower-income spouse in order to take advantage of the lower-income spouse's lower marginal tax rate.

Let's assume you are the higher-income spouse. This strategy involves you loaning funds to your spouse at the Canada Revenue Agency's prescribed interest rate, which fluctuates and is currently at 1%. Your spouse will then invest the borrowed funds for the purpose of generating investment income. This investment income will be taxable to your spouse at their lower tax rate, which effectively reduces your family's overall tax bill.

Let's go through a quick example. Let's say you are in a top tax bracket and you earn a 5% return in the non-registered investment account outside of RRSPs and TFSAs. This 5% gain is then taxed at your marginal tax rate of 53 and 1/2%. Let's also assume your spouse's tax bracket is much lower than yours, at 25%. By lending funds and letting your significant other invest to earn the 5% return, we have effectively reduced the tax bracket on the earned income from 53 and 1/2% down to 25%. Thus, you are cutting the tax bill in half. You are still the owner of assets you've lent your spouse and you can demand the loan repayment at your discretion.

Another effective strategy to reduce family tax bills is by lending non-registered funds to a family trust. A family trust may allow a higher-income family member such as a parent or grandparent to split income with their lower-income family members. This strategy is aimed at shifting future investment income that would otherwise be taxed at the higher marginal tax rates to your lower-income family members.

The family trust method involves you loaning funds to a family trust at the CRA's prescribed interest rate of 1%. The trustee then invests the borrowed funds for the purpose of generating investment income. The investment income can be allocated and taxed at the rate of your lower-income family member. This is another way to cut your family's overall tax bill. As such, each beneficiary can earn approximately $12,000 of interest income, $24,000 of capital gains, or up to $52,000 of eligible Canadian dividends tax-free every year if they have no other income. Similar to the spousal loan strategy, you are still the owner of the assets you've lent to the family trust and you can demand the loan repayment at your discretion.

Let's look at the third solution for spouses with different income tax brackets. A spouse with little to no income should own Canadian dividend-paying stocks so that up to $52,000 worth of dividends can be earned tax-free. Meanwhile, the higher-income spouse would own bonds and foreign dividend-producing stocks that are taxed at a much higher rate.

Finally, the fourth strategy you may consider is to own bonds and GICs in registered accounts like TFSAs and RRSPs. This way, the least tax-efficient source of cash flow from bonds and GICs is sheltered from taxation. Meanwhile, stocks that produce tax-efficient capital gains and dividends are held outside of registered accounts and exposed to taxation.

It is important to recognize that not all types of investment income are taxed in the same way as shown here. For example, capital gains and Canadian dividends are taxed at more favorable rates than interest income and foreign dividends. It's understandable why investors may want to gravitate toward more tax-efficient Canadian dividends and capital gains.

However, it's critical to recognize that the risk associated with receiving dividend income from stocks is generally higher than the risk associated with collecting interest income from bonds and GICs. It is important that you make investment decisions that are appropriate in the context of your personal risk tolerance. The tax savings should be a secondary consideration to the investment merits. It wouldn't make sense to save $0.10 on the dollar in tax and then lose $0.50 on the investment.

In conclusion, I strongly encourage you to reach out to me and your accountant to make sure you leave no stone unturned when it comes to tax planning. I suggest you explore further the tax-saving strategies described in today's episode and consult with your accountant to see if they are suitable for your specific situation. Thank you for watching and spending your precious time with me. Stay safe and be well.

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Welcome to the May episode of Bay Street Views. My mission is to educate, inform, and help you make intelligent decisions in financial markets that are increasingly complex. In today's episode, I'd like to discuss the driving forces behind the recent drop in the US dollar and its outlook for the future as well as the benefit of holding the US dollar as a risk-mitigating strategy.

Let me start by sharing three important observations about the US and Canadian dollar relationship. First of all, the US is perceived as the best house in a bad neighborhood. When the global stock market is in turmoil, investors seek the safety and liquidity of US government bonds. Overseas investors convert native currency into the US dollar, which is then used to purchase US government bonds. In turn, higher demand for US bonds drives the value of the US dollar up.

The opposite is true when investors get optimistic about the global economy. Foreign investors would sell safe-haven assets like US government bonds, then use the proceeds to buy riskier currencies and assets worldwide. So in most cases, when global equities are going up, the Canadian dollar goes up, and the US dollar goes down and vice versa.

Another observation is in regards to the impact of the price of oil on exchange rates. In most cases, the Canadian dollar and the price of oil move in tandem, while the US dollar and oil tend to move in opposite directions. Oil is priced in the US dollars across the world. When the US economy is growing, demand for oil tends to go up.

About 95% of Canadian oil exports go to the US. When Canada collects US dollars for its oil exports, a good portion of those proceeds is converted back to Canadian dollars. When oil prices are high, Canada receives more US dollars. As a result, a larger amount of American dollars is converted to Canadian currency, which drives demand and the value of our currency up. Conversely, when the price of oil is low, Canada collects and converts fewer US dollars into Canadian currency, thus putting downward pressure on the Canadian dollar.

The third and equally important observation is around the influence of prevailing interest rates in Canada versus the US. If the American economy is growing faster than Canada's economy, it's most likely that the Federal Reserve, America's central bank, will raise interest rates ahead of Bank of Canada in effort to prevent the economy from overheating. If US interest rates rise faster than interest rates in Canada, then Canadian investors might be tempted to park their funds in US savings accounts in order to benefit from higher interest rates. The opposite is true if Canadian rates rise quicker than American rates.

Now that we have covered some of the basics of what typically drives US-Canadian dollar exchange rates, I'd like to discuss some of the recent trends. Over the past year, the Canadian dollar has been on a roll, while the American dollar has been under siege. Investors continue to gain confidence in the global economy's recovery, which has been boosted by the widespread rollout of vaccines around the world. As is shown in the following chart, the hopes of better days ahead let the riskier assets, like the Canadian equities and the Canadian dollar, to rally roughly 77% and 20% respectively from their lows in March 2020.

In the meantime, safe-haven assets like US government bonds are off by 5%. With improving economic activity, demand for oil has recovered, leading to a surge in the price of oil, which went from a negative $37 per barrel last summer to over $67 per barrel today. Higher oil prices have boosted the Canadian dollar.

Another important factor supporting our currency has been the recent announcement from the Bank of Canada that they will gradually make borrowing less cheap. Let me explain. Much like other major central banks around the world, the Bank of Canada came to the economy's rescue at the outset of the pandemic by aggressively purchasing government bonds in the open market.

This helped to keep the longer-term borrowing costs at ultra-low levels. By now that the economy is healing nicely, it doesn't need as much stimulus going forward. The central bank said that it will reduce its weekly purchases of government bonds to $3 billion from $4 billion.

So Canada's willingness to scale back on cheap money has pushed the value of the Canadian dollar higher. Now, you might be wondering, what's next for the Canadian dollar? In my opinion, the loonie is likely to march higher in the near term, but the upside is limited. As long as investors continue to feel confident about the prospects of the global economy, the loonie should be on a firm footing.

But two factors should put downward pressure on the Canadian dollar and boost the American dollar in the medium to longer term. The first factor is that the growth of the more diverse and robust US economy is likely to continue to outpace Canada's commodity-heavy economy. Stronger US economic growth should lead to higher interest rates compared to ours in Canada. And that should support the US dollar.

The second factor is that I do expect the global economy to start to decelerate by the end of the year, and so should the demand for oil as shown on this chart. Again, this should be negative for the loonie and positive for the American dollar. RBC Capital Markets anticipates the US dollar to appreciate roughly 6% over the next 12 months. This is just an estimate, and I'd like to remind our viewers that there are too many variables that impact currencies to make forecasts with any degree of real certainty.

So why would you own the American dollar in your portfolio? Because in every stock market correction over the past five decades, the US dollar has gone up. So the American dollar can help you mitigate some of your losses when the market drops.

During the peak of the financial crisis in 2008 and 2009, the S&P 500 equity benchmark lost over half of its value. But the US dollar went up by 20%. And last year, when the market cratered by over 35% during the height of the crisis, the American dollar went up by 10%. So owning the US dollar can serve as one of the many lines of defense against severe losses in your portfolio during a crisis.

To conclude today's episode, I'd like to remind our viewers that losses always hurt more than gains feel good. So we always want to own assets that don't move in the same direction at the same time. Being exposed to the US dollar may somewhat curtail your profits when markets go up, but conversely, it can also help you reduce your downside when equities tumble.

Thank you for watching. Please feel free to reach out if you have any questions. I'm always glad to hear from you, and I welcome your feedback. Stay safe, and be well.

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Welcome to Bay Street Views. My mission is to educate, inform, and help you make smart financial decisions, avoid financial accidents, and become a better investor.

In today's episode, I would like to discuss the ongoing tug-of-war between value and growth stocks. Typically, value stocks are seen as priced less than the market based on factors like current price to expected earnings. These companies grow in lockstep with the economy.

Usually, value stocks are found in economically sensitive sectors like energy, banks, industrials, and retail. In comparison, growth stocks are typically found in the technology and certain parts of the healthcare sector.

Growth companies are perceived as priced higher than the broad market. And they tend to have more elevated price-to-earnings ratios. These businesses tend to grow much faster than the GDP.

Sluggish economic growth over the past decade has made growth stocks particularly appealing to investors. As such, growth equities have substantially outperformed the value stocks, as shown on the following chart.

However, over the past few months, the growing optimism about the economy pushed the most beaten down value stocks to outperform more resilient growth-oriented equities. The value stocks that were crushed during the pandemic had the most to gain from the accelerating vaccine deployment and the rising economic activity. With an improved economic outlook, the chances of impaired businesses going under diminished. Companies with the weakest balance sheets substantially outpaced stocks with the strongest balance sheets, as shown on the next chart.

In the near term, the markets tend to reward companies with the most year-over-year earnings growth, even if these businesses are in volatile sectors. However, in the long run, businesses with more predictable and consistent profits tend to increase in value the most.

Let me elaborate. Over the next couple of quarters, businesses in technology and healthcare that did well last year will have less robust year-over-year earnings growth than cyclical companies that did poorly last year.

Let me give you a quick example. In 2020, when the economy was in a tailspin, Microsoft managed to grow its profits 26% from the year before. Over the past decade, the company increased its earnings by an impressive 11% per year. Demand for its products and services has surged during the pandemic as the digital transformation accelerated in all facets of the economy.

In the meantime, Caterpillar, the world's largest construction equipment manufacturer and global economic bellwether, saw its 2020 earnings plummet 41% year-over-year. Over the past decades, the company grew its earnings by less than 3% annually. The pandemic was most unkind to economically sensitive businesses.

However, by mid to late 2021, the economy is expected to fully recover from the recent crisis and continue its ascent in 2022. Next year, Microsoft is projected to increase its profits by 32% relative to very healthy earnings in 2020. However, Caterpillar is expected to boost its earnings by a whopping 66% from the very depressed levels in 2020.

Now, major economies are expected to grow at a remarkable 5% to 8% this year. As such, economically sensitive value stocks are likely to post phenomenal recovery in earnings, and may even outperform growth stocks.

So why not put a substantial portion of the portfolio into the value stocks with more near-term earnings upside rather than consistent performers in growth sectors? Well, it comes down to how much risk you are willing to accept. I do believe there are more reasons for the economy to thrive over the next couple of years than not. But it's the responsibility of a diligent investor to contemplate possible damage to the portfolio should the economy's rapid recovery be interrupted by unexpected and adverse events. I can't entirely dismiss an improbable, but not impossible, scenario such as vaccines becoming less effective against the new variants of COVID-19. What are the economic ramifications should a large portion of the population decline vaccination?

Another risk factor to be aware of is the unintended consequences of too much government debt on the economy. Value stocks are likely to be most vulnerable to potential negative economic surprises. Growth stocks may hold up better during times of increased uncertainty, as they have often done in the past.

In conclusion of today's episode, I'd like to reiterate the benefit of not betting the farm on a single outcome or prognosis in the market. It does make sense to own some value stocks which should thrive when the economy reopens. But make sure you hedge your portfolio by keeping a healthy allocation to reasonable priced, unkillable businesses in technology and healthcare.